When it comes to running a corporation, planning for the unexpected is just as important as day-to-day operations. One critical but often overlooked safeguard is a well-drafted shareholder agreement.
Imagine a scenario where a shareholder unexpectedly passes away or decides to retire. Without a well-drafted shareholder agreement, the shareholders could face significant legal and financial challenges and expenses. These include disputes over ownership and control, leading to costly legal battles; valuation disagreements requiring expensive external experts; and complications in exiting the company, which may result in prolonged negotiations or litigation. Additionally, the absence of clear buy-sell provisions can leave shareholders facing unexpected tax liabilities or difficulties in handling the death or disability of a shareholder.
Ownership of a corporation is held in shares of stock. Shareholders or stockholders have the right to, and as a best practice should, enter into a contract that clearly explains the rights and responsibilities of each shareholder. These contracts can outline ownership interests, employment and payment rights, distribution rights, access to corporate documents, and any other agreements the shareholders want to make.
Notably, shareholder agreements can also preemptively address what happens when a shareholder dies, retires, or otherwise wants to divest their shares. In a recent matter handled by CMM’s litigation team and led by litigation partner David Green, owners of a corporation’s shares spent significant resources litigating over the value of the corporation so that one shareholder could sell their shares. The shareholder’s agreement was silent on any valuation methodology.
In contrast, a shareholder’s agreement can include a specific formula to determine valuation, or even a specific value per share. Spending the time, money, and resources upfront to assess and plan for a share sale would have saved the client tens of thousands of dollars in the long run. This real-life example underscores the importance of proactive planning.
Moreover, minority shareholders may be at risk of oppression without adequate contractual protections, and unclear roles or compensation structures for working shareholders can lead to internal disputes. Finally, without defined ownership of intellectual property or company assets, shareholders could face costly legal conflicts.
Maintaining a comprehensive and up-to-date shareholder agreement is crucial for any corporation. The best practice for any corporate shareholder is to create and regularly assess your shareholder’s agreement. Learn more:
For more input and guidance on business divorce, reach out to David Green at 631-738-9100.
Thank you to Alex Tomaro for his research and writing assistance.
